Alternative Insight – December 2015

The Senior Managers and Certification Regime: what does it mean for Alt Asset Managers?

Over the next two years the Senior Managers and Certification Regime will progressively cover the whole of the UK financial services industry (other than the insurance sector), replacing the Approved Persons Regime (APR). What can private equity and hedge fund managers expect?

Out with the old, in with the new

Over the next two years the Senior Managers and Certification Regime will progressively cover the whole of the UK financial services industry (other than the insurance sector), replacing the Approved Persons Regime (APR). What can private equity and hedge fund managers expect?

The Approved Persons Regime has served for many years as the basic UK framework for authorising individuals who perform “controlled functions” at any financial services firm. It was meant to enable regulators to hold to account individual decision-makers at financial firms for their responsibilities, but has been pilloried since the financial crisis for failing in precisely that regard. In 2013 a parliamentary commission even described the APR as a “complex and confused mess” which “does not ensure that individual responsibilities are adequately defined”.

The supposed fix for these problems is now finally upon us. The APR is going to be abolished and replaced by the new Senior Managers and Certification Regime (SM&CR). The SM&CR will apply first to banks from March 2016 and then gradually roll out over the following two years to cover all UK financial services sectors (other than insurance) including asset managers.

What’s really changing?

Generally, the SM&CR is aimed at improving governance and risk management by emphasising personal accountability within financial firms, particularly for senior management. The regulators have also said that firms will need to comply with the “spirit of the rules”, rather than just doing what the letter of the law requires.

More particularly, the SM&CR differentiates more clearly than the APR between the ‘big beasts’ and the smaller fry.

The APR was concerned with people who exercised “significant influence” over a firm’s affairs, even though many of them wouldn’t necessarily be senior decision-makers at their firm. By contrast, the SM&CR, as its name suggests, is really two regimes in one because it recognises this distinction:

  • The “SM” part of SM&CR applies to the former and imposes tougher duties and standards on individuals who perform Senior Management Functions (SMF), e.g. the CEO role.
  • The “CR” part of SM&CR refers to the Certification Regime. It is aimed at individuals who are not SMFs but who nevertheless perform roles which, in the FCA’s opinion, might allow them to cause significant harm to the firm and/or its customers. The APR’s CF30 positions (e.g. customer facing roles like advisors and portfolio managers) will almost certainly fall under the new CR.
  • Firms can also expect new Rules of Conduct to be brought in by the regulators for a wide range of individuals, from senior managers down, as a replacement for the narrower ‘statements of principles’ that operate under the APR.

Senior managers’ personal responsibility

In the debate on replacing the APR, the more radical reformers wanted to impose a “reverse burden of proof” on senior managers. If something went wrong, this would effectively have required the individual to prove that he wasn’t guilty (rather than requiring a regulator or prosecutor to prove that he was).

Fortunately for senior management, this controversial idea has been dropped. Instead, a statutory duty of responsibility will apply to all senior managers in a regulated firm. In any enforcement action, the regulators will have to prove not only that a firm has breached regulatory requirements and that the contravention occurred in the part of the business for which the senior manager was responsible, but also that the individual failed to take such steps that a person in the senior manager’s position could reasonably be expected to take to avoid the occurrence and continuance of that regulatory breach.

Senior managers aren’t off the hook, however, as they will still have to show that they have operated in accordance with best industry practices for identifying and dealing with potential and actual regulatory breaches.

Getting someone approved

The approval and assessment procedure under the SM&CR will be ongoing rather than the regulator-run ‘gateway’ approach that prevails under the APR.

Although firms can ‘grandfather’ into the equivalent SMF roles individuals who are already approved to perform them, they will have to apply for fresh approval for any new hires and promotions and for anyone performing an existing role that materially changes.

Alongside its application, a firm will also need to prepare and submit a statement of responsibilities and a management responsibilities map. Further, it will have to show that it has investigated the candidate thoroughly by assessing his suitability, running criminal record checks and obtaining references from past employers. The regulatory agencies will then assess whether the prospective candidate is fit and proper for the particular role.

Even under the CR, a firm will itself need to assess that individuals are fit and proper to perform key non-SMF roles and they will have to formally certify this at least annually. With more people below senior management level potentially caught by the CR, this will favour large firms that have advanced systems to monitor the changing parameters of employee roles and performance.

One positive change (for regulated firms) is that prior approval to fill a role is not necessary. However, costs per application are likely to increase due to the additional paperwork and due diligence required from firms.

What can fund managers do now?

PE and hedge fund managers have some time to prepare as the SM&CR won’t affect them immediately. There are a number of preparatory steps that they can and should take, sooner rather than later, to ensure that they are ready:

  • Consider what the entities and people in your corporate group actually do and how significant they are to the business.
  • Draw up a responsibilities map and organisational chart. Keep them up-to-date. Give ongoing consideration to whether there are any gaps or missing individuals.
  • Allocate senior management responsibilities clearly, across group companies if necessary.
  • Know your staff, diligence their background and make sure they’ll meet the ‘fit and proper’ tests.
  • Start thinking about additional staff training, upgrades to computer systems and updates to internal compliance manuals.
  • Keep good written records.

Conclusion

The FCA has suggested that the SM&CR should not be seen as just another compliance burden, urging firms to see it “as a chance to streamline their structures, to reinforce values they have always espoused and to empower and inspire their staff”. Whether alternative asset managers will see it in quite these terms is debatable. They would be forgiven for feeling something like ‘regulatory fatigue’, as wave after wave of new rule-making sweeps over them. But the reforms are likely to be far-reaching when it comes to how firms and individuals are held accountable and thus merit serious consideration.


 

Alternative Insight is produced by MJ Hudson’s private funds lawyers. We provide expert legal advice to fund managers, other financial sponsors, investors and advisers on the formation, structuring, investment into and regulation of private funds, managed accounts and similar vehicles. Our practice covers the full spectrum of alternative assets, including private equity, venture capital, hedge funds, private debt, real estate and infrastructure. Clients praise our entrepreneurial approach, commercial outlook and dedication to helping them achieve their objectives, regardless of the obstacles.